Tuesday, 30 October 2007

The Myth of Islamic Finance

One of the latest additions to such urban legends as the Loch Ness monster, UFO’s and environmentally friendly land reclamation is what is now known as Islamic Finance. A new scam that started in the second half of the twentieth century and only really took off in the last three decades. One could wonder why the Islamic world needed 1,400 years to invent such a system. One may also wonder why we never hear of such terms as Christian, Jewish or Hindu Finance?

How it works?

In a process known as Murabaha a person decides to purchase an asset (car, home) via an Islamic bank which buys it in its own name and immediately “resells” it for a higher amount which ultimately works out to be equal or higher than conventional interest[1]. In the meantime the bank retains ownership of the asset until the client is able to pay back the entire amount plus the finance charges. Basically, Islamic banks make more money and take much less risk, the burden of which rests solely on the Shariah compliant client.

How it started?

The development of this fast growing industry that preys on the religious beliefs of 1.2 billion people is that a few terms were literally translated from English into fancy sounding Arabic words to appeal to the pious. Words such as Lease became Ijara, Bonds turned into Sukuk, Joint Venture changed to Musharaka and Insurance morphed into Takaful[2]. Folks, the truth is, all the above words are literal translations from English to Arabic and have nothing to do with Islam. For non Arabic speakers it is similar to saying flat in British English and apartment in American English which is very acceptable. What is not acceptable however is when one is expected to pay much more to buy the very same flat should the seller decide to call it an apartment in the contract.

Also, for those who believe in the sham of Islamic banking, turning a regular bank into an Islamic one by changing its name or logo does not make it an “Islamic bank”. It is clearly set in Islamic principles that if money that was used to start a business was itself tainted then everything that was built upon it is so and cannot be laundered or white washed no matter how many fatwas are collected.

There are various reasons behind the emergence of this belief-finance system. In Malaysia it was seen as a way to grab a share from the more developed hubs of Hong Kong and Singapore; in the Gulf, Western banks wanted to offset any migration of long established customers to fledgling banks that have window-dressed their names as well as capture a new slice of the $1.5 Trillion estimated wealth in the region[3]

Is it regulated?

Once again, as in the case of the Arab League, GCC Customs Union and the Peace in the Middle East, it was decided to outsource the establishment of what make up so called Shariah compliant regulations to the Western world[4]. Even so, the current lack of standardization of Islamic Finance came under attack in a recent McKinsey report that called it “an industry that is little more than a collection of national strongholds."[5]

For an industry that claims it has $500 Billion dollars under management[6] having "no common approach on regulatory frameworks” as a KPMG report found coupled with a “lack of transparency in operations" doesn’t bode well for its clients[7].

Did you ever wonder why in the Kingdom of Saudi Arabia which is the cradle of Islam there isn’t one openly Islamic bank? And yet the UAE with 20% of KSA’s population has five such banks, three of them white washed. In KSA when a client goes to open a deposit account banks openly ask her if she wants a “riba account” which means an account that pays interest, the majority of clients decline as it is seen as “morally unacceptable[8]” which leaves the banks to rack in the profits. With deposits approaching $150 Billion in 2006 and little interest charges to pay the clients no wonder they are amongst the most profitable banks in the world.[9]

A professor from the WhartonSchool in the US argued that “it serves little purpose to extend financing with interest charges using a set of tricks that disguise them as something else.[10]” In today’s world, more and more people are looking for salvation, even if it was a trick; in this case salvation got an Islamic disguise.

3 comments:

I once interviewed the (muslim Gulf Arab) chairman of a prominent - and possibly extremely close to your home - Gulf Islamic bank.

He described Islamic finance as a "phase" which he expected - and gave every indication he hoped - would be over in another decade or so.

Other analysts predict greater longevity, but I think the biggest concern is the potential for corruption in securing the vote of sharia "approval" eg for an IPO from a currently miniscule pool of Islamic finance scholars.

Though when push comes to shove, money trumps morality for most investors whether western or eastern, so I doubt even officially-deemed-sinful corporations such as Kingdom Holdings will suffer too much from their shariah-compliancy blackballings.

i've always been of the same inclination that its simply using a different name to say the same thing and jacking up the price unfairly because you seem to offer something others don't so the supply demand ratio is currently in favor of the islamic banks.

this trend could still have a lot of steam but i would agree that in the ultra long term (when people should be more savvy), return for both industries - conventional and islamic - will converge.

shame on some banks for labeling their deposit accounts with unattractive names. how do you get a license? :)

Sultan Sooud Al Qassemi is an Op Ed contributor to a variety of publications. His articles have appeared in The National & Gulf News in the UAE as well as Foreign Policy, New York Times, The Guardian, The Independent and the Financial Times.